The Smart Money: Economic Armageddon

Posted Tuesday, October 8, 2013 in Analysis

The Smart Money: Economic Armageddon

by Gina Hamilton

No doubt you are seeing headlines like "Economic Armageddon" related to the debt ceiling debacle currently playing out in Washington D.C., and we have to use the term "playing" advisedly.

Just to recap what's happened so far: The House Republicans submitted a budget to the Senate, and after a little back and forth, the Senate Democrats approved the House's numbers for the continuing budget resolution, even though they were $70 billion or so below what the Senate thought was necessary.  So the CR got back to the House for a final vote and then, after all that, despite Speaker Boehner's assurances that his body would pass a clean bill, the House decided to attach a rider to the CR that would defund the Affordable Care Act. 

That was a non-starter in the Senate, and the bill was voted down.  And after ping-ponging the bill back and forth between the two houses, the government ran out of money on day one of the fiscal year, and shut down.  Now, parts of it didn't shut down, because they fall within a special category of programs that are "essential", or they are funded outside of Congressional appropriations, which makes them what we call "entitlements". And more people, during the shut down, which is now in its ninth day, were re-assigned to the "essential" column, but not all.  If you're a civilian worker for a shipyard, you're probably back at work.  If you're a ranger in a national park or forest, you probably aren't. 

But this was just a minor taste of the pain that will happen if the government doesn't pass a debt ceiling increase on Oct. 17.  The Constitution and a federal act called the Second Liberty Bond Act of 1917 are contradictory on the subject.  The fourteenth amendment to the Constitution says this about public debt:

The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.

However, the WWI-era Liberty Bond Act establishes a debt ceiling for the first time, and gave the executive branch the authority to spend up to that debt ceiling.  Congress has the power to raise or lower the debt ceiling; however, the executive still has the obligation to pay bills already incurred, including pensions (Social Security, VA, and federal workers, and, now, a portion of pensions abdicated by companies that go bankrupt). We are also mandated to pay the interest on the debt.

The U.S. has never defaulted on its debts.

So the executive branch is in a bit of a bind.  They can follow a World War I era act of Congress, or they can follow the Constitution, but unless Congress raises the debt ceiling, they can't do both.  If you were the President and the Treasury Secretary, what would you do?

You'd try to get Congress to do its job first, I suspect, but since the House Republicans have  dug their heels in, you'd start looking for other options. No matter what you do, you're breaking one law or the other and the House GOP is likely to impeach you over it.  So you'd likely pick the option that's likely to cause the least harm to the most people.

In other words, you'd ignore the debt ceiling and pay the bills - all of them.

That way, you keep the economy on an even keel and let our creditors breathe again.  Will it be enough to encourage people to keep investing in the U.S.? That's difficult to know.

One of the worries is that there would be a two-tier bond system.  Right now, people buy bonds in short term treasuries because they're considered rock solid safe, even if they don't earn any money on the bond (such as is currently the case).  Will people buy them if they don't have Congressional blessing? Will people still accept that the full faith and credit of the United States is still the place to stash their cash?

The answer is "probably".  If the U.S. offers bonds, they will be indistinguishable from bonds already issued. Our creditors know what our debt is, and they're still buying our bonds now, and not demanding higher interest rates because of our high debt.  In fact, the opposite is true.

Will the market react positively or negatively to smashing the debt ceiling?

The market would react very poorly if the U.S. stopped paying its obligations, so despite the novelty of the situation, it's likely that the market would be so relieved that it would probably even rally on the news.

What if Obama used his executive powers to have coins made - a couple of trillion dollar platinum coins, say - and deposited those in the treasury to bring down the debt so that he didn't have to smash the debt ceiling, but instead "paid" it down?

That's the only option that would theoretically leave the debt ceiling intact while still continuing to pay our obligations, and it's certainly an idea that's received some coverage in recent months.  The threat is that the "coins" would have the effect of devaluing our currency and could lead to inflation at home, and higher interest rates on bonds in the future.  And there's no guarantee that the House wouldn't attempt to issue articles of impeachment if Obama did so.  Now, like much done in the House during this Congress, an impeachment proceeding would go absolutely nowhere -- the House would spend most of the winter grandstanding, then issue the articles, then the Senate would quickly schedule a vote and defeat the measure.  But it would take time away from the people's business in an election year, perhaps score some tea party points, and possibly swing the election in heavily tea party districts.  

Whichever option the President chooses, it likely won't be the one letting the House Republicans kill the full faith and credit of the United States.  But the deadline is coming up in nine days.

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